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Abstract
Positive political economy is usually concerned with economic explanations of observed
policy choices, while the timing of a policy reform has not gained similar attention. This is
somewhat surprising since policy makers most often are free to decide both the design and
timing of a policy reform. Drawing on insights from recent developments in the finance
literature on investment under uncertainty, here we apply the idea of option value to the
analysis of government policy making.
Common political-economic explanations of the 1992 CAP reform are that policymakers
felt domestic political pressure to make the CAP more efficient, and also international
political pressure and to bring the CAP in line with treaty obligations. Although these
arguments are sound, they fail to explain why policy-makers did not enact the reform earlier,
especially during times of decreasing world market prices prior to 1992. We address this
question using the theory of option value, which is the value of being able to wait in decisionmaking.
Commonly governments are free to decide when to reform policy. Waiting to
reform policy can improve government decisions. For while waiting decision-makers may
observe market parameter changes as they occur. (For example, they may obtain better
information about changes in world prices.) This reduces their uncertainty about the effects
of their decisions. Giving up the option to wait incurs a cost which has to be taken into
account in policy decisions. We illustrate the option value concept using a political-economy
model of the 1992 CAP reform. We show empirically that if decision-makers had not had the
option to wait to reform policy, it would have been more efficient to implement the 1992 CAP
reform in the mid 1980s.